Module 5 – 5.3 Valuing Risk : certainty Equivalents or Expected Utilities
This short clip explains – for those who are interested – the relationship between the certainty equivalence approach to valuations of risky strategies and the expected utility approach. Briefly.
Our course is introductory and interdisciplinary, so we use a simple “connect the dots”, graphical approach to valuing risks for players in the games we look at. This approach is based on the intuitive idea that valuations can be expressed in terms of the payoff medium (e.g. money, work effort, net benefit…) as something between the best and the worst possibility. EU and Prospect theory require much more heavy lifting in terms of intellectual requirements – completely appropriate to a third year under gad course with a microeconomics prerequisite – but not for this course.Note to self: plan to develop a Mathematica CDF file to permit students to play with various possibilities for risk attitudes that enables them to see the logical relationships between these two approaches clearly, graphically, and without any heavy math.